Question

X-treme Vitamin Company is considering two investments, both of which cost $12,000. The cash flows are as follows:

Year	Project A			Project B
1	$	13,000		$	12,000
2		5,000			4,000
3		6,000			11,000

Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a-1. Calculate the payback period for Project A and Project B. (Round your answers to 2 decimal places.)
  

	Payback Period Project A year(s) Project B year(s)

a-2. Which of the two projects should be chosen based on the payback method?
  

	Project A
	Project B

b-1. Calculate the net present value for Project A and Project B. Assume a cost of capital of 8 percent. (Do not round intermediate calculations and round your final answers to 2 decimal places.)
  

	Net Present Value Project A Project B

b-2. Which of the two projects should be chosen based on the net present value method?
  

	Project B
	Project A

c. Should a firm normally have more confidence in the payback method or the net present value method?
  

	Payback method
	Net present value method

Answer 1

a-1.Project A

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 0 years + ($13,000 - $12,000)/ $12,000

                              = 0 years + 0.0833

                              = 0.83 years.

Project B

Payback period= 1 year since the first year cash inflow is $12,000.

a-2. Project A should be chosen based on the payback method since it has the lowest payback period.

b-1.Project A

Net present value is solved here using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$12,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter cost of capital of 8%.
• Press the down arrow and CPT buttons to get the net present value.

The net present value at 8% cost of capital is $9,086.92.

Project B

Net present value is solved here using a financial calculator. The steps to solve on the financial calculator:

• Press the CF button.
• CF0= -$70,000. It is entered with a negative sign since it is a cash outflow.
• Cash flow for all the years should be entered.
• Press Enter and down arrow after inputting each cash flow.
• After entering the last cash flow, press the NPV button and enter the cost of capital of 8%.
• Press the down arrow and CPT buttons to get the net present value.

The net present value at 8% cost of capital is $11,272.62.

b-2.Project B should be chosen since it has the highest net present value.

c.A firm should have more confident in the net present value method since using the net present value , the firm can select the project which maximizes the wealth of the shareholders. The payback period only gives information on the time taken to recover the initial cost of investment

In case of any query, kindly comment on the solution.